We can’t decide between leasehold and freehold…

Thursday, March 23rd 2006, 0:00

Thursday, March 23rd 2006, 0:00

We’re thinking of buying an inn, which we see as a five- to seven-year project before possibly selling and moving on. We can’t decide between leasehold and freehold. Would we get a better return by buying four leaseholds at £100,000 rather than one freehold at £400,000? We have £200,000 in cash to invest

The solutions

Hugh Caven, Walbrook Commercial FinanceAssuming that your objective is to maximise the end return in seven years’ time, the single freehold option is the safer and more likely to achieve your aim.

If we set aside £50,000 of your cash for costs and working capital you could afford an inn at about £600,000. Depending on location, you would expect a turnover of about £285,000 and a possible profit of around £40,000 after finance but before depreciation and drawings.

In seven years’ time, based on price trends of the last seven years, you should comfortably expect to achieve a selling price of more than £700,000, assuming the trading results are similar to or better than when you bought. At the time of sale you’d have paid off £95,000 of your loan, thus netting a minimum of £345,000, plus any retained trading profit.

Your idea of four leaseholds fills me with terror. At the purchase price you’ve indicated and assuming at least three would be under management, it’s rare that I would ever recommend a cocktail of mortgage debt, rent and management salary at this level of entry. To test my theory, I researched 10 leasehold pubs currently for sale at around £100,000. The average rent payable was £34,000, and when I added the cost of a 60% loan and the cost of management, I struggled to get any to show a profit.

You’d be very lucky to find a cluster in close proximity, so overseeing four separate units would be time-consuming and costly in terms of stock control, marketing and staff development.

In seven years’ time your assets would have depreciated, and they would have to come to the market very much improved in terms of trading for you to regain your original investment.

Colin Wellstead, Christie & Co Christie & Co is about to launch the disposal of 213 public houses on behalf of Punch, and these are probably the best pubs ever to come on to the lease market, so a great option if you’re considering a leasehold.

You’d pay rent at the open market rental rate, which will go up with inflation and be subject to five-yearly reviews. You could sell the lease after two years.

With a leasehold pub, there’s generally a tie for beer, although the range that most pub companies now offer is vast. Under typical terms the lessee keeps the profits, bears the losses and can sell the business (but not the property) for whatever it’s worth (its premium value). This would depend on profitability, the number of years of the lease remaining and the value of the fixtures and fittings, plus stock at valuation. You can purchase an existing lease with the benefit of goodwill and trading accounts at a premium. The cost for acquiring a lease can vary, but typically the total ingoing for, say, the Punch pubs would be £100,000 for everything.

The freehouse licensee has the freedom to choose suppliers. The freeholder can lease out the pub in due course, run it under management, or sell. A freehold freehouse is usually the most flexible and secure kind of ownership. The average freehouse turnover is £4,000-£8,000 a week, excluding VAT.

To buy a freehold pub you have to pay for everything, including the property and the goodwill of the business. This is the most expensive form of entry into the pub trade. A freehold can cost anything from £200,000 up to £1m or more.

Yaser Martini, FleuretsYour initial £200,000 cash outlay should enable you to acquire a run-down freehold property, borrow sufficient capital to refurbish the premises as well as providing you with sufficient working capital to see you through the early stages.

However, given the likely purchase price, you’d be in a less affluent area. Turnover would probably be £200,000-£250,000 a year, and depending on your style of operation a net profit of £50,000-£65,000 a year would be likely.

Conversely, an initial cash outlay of £100,000-£125,000 might mean you’d be able to buy a leasehold property with greater choice of location and also enable you to refurbish and redecorate to suit your requirements. In this example, your leased pub would be more likely to take somewhere between £350,000 and £400,000 a year and yield you a similar return on the bottom line.

Another consideration is whether you’d wish to own and operate one premises or manage multiple businesses. We often find that once people make the transition from running one premises to two, they may as well “bolt on” another one or two operations, finances permitting, because the effort involved in running more than one property is similar at this level.

It’s wise to bear in mind your exit plan. Freeholds are increasingly a scarce commodity and it’s difficult to see this changing in the foreseeable future. The laws of supply and demand would probably mean that your investment was safe into the longer term.

However, the market for groups of leasehold premises – in particular, tied leases – isn’t currently strong enough to ensure a wholesale package disposal, and your exit from the multiple leasehold scenario might need to be taken in stages.